Everything Uber doesn’t want you to notice in its IPO

Don’t look behind the curtain.
Don’t look behind the curtain.
Image: Reuters/Shannon Stapleton
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Last week, Uber filed its S-1—the regulatory paperwork necessary to go public—and at first glance it looks great.  The number of people using the platform is growing, the number of trips is growing, the company’s revenue is growing, and its ride-hailing business was profitable in 2018—if you look at the numbers the way the company wants you to. Below the surface, though, things look a bit different. This raises many questions about the company’s performance during 2018 and the risks that the company is asking investors to take on as part of its IPO. Here are the five biggest risks we think investors should be monitoring closely.

Risk No. 1: Uber’s user and trip growth

The good news: Uber’s number of users and trips grew in 2018
The not-so-good news: The amount of revenue Uber made per user and per trip declined in 2018

The number of people using Uber and the number of trips people took with Uber grew 34% and 37%, respectively, in the past year. But the amount of money Uber made per user and per trip declined by 15% and 17%, respectively. This story looks worse when you look at the performance quarter-by-quarter in 2018 when the growth in the number of users and trips accelerated during the year while the amount Uber made decelerated.

It’s unclear from the S-1 what’s behind this decline. The mix of Uber’s revenue across geography and business unit is a likely culprit. Uber takes between 12% to 25% from drivers for each ride-hailing trip depending on the city and country, so any material shift in business around the world can make a big difference. The growth of Uber Eats has also had an impact. Bookings from Uber Eats have grown significantly and now represent 16% of total Uber bookings in 2018, up from 9% in 2017. But Uber makes less than half as much per trip delivering food than delivering people, so Uber Eats only represents 8% of total Uber revenues, up from 5% in 2017.

Competitive pressures could also be reducing the amount of money Uber makes. But its primary competitor in the United States, Lyft, made more money per user and per trip each quarter in 2018. That suggests Uber’s lost revenue is most likely due to the 52% of its business that is outside the US. Given the company is continuing to expand into lower-margin international markets, it seems likely that Uber’s revenue per user and trip will continue to decline.

Risk No. 2: Uber’s revenue decline

The good news: Uber’s revenue grew 42% in 2018
The not-so-good news: Uber’s ride hailing and Uber Eats revenue declined in the fourth quarter

Uber’s business grew significantly in 2018 with gross bookings increasing by 45% and revenue increasing by 42%. But that performance peaked at the beginning of 2018 and declined throughout the year because Uber earned progressively less per booking. Throughout 2018, Uber’s share of revenue from the total bookings on its platform fell from 22% at the beginning of the year to 18% at the end of the year. So while total bookings increased by 11% in the fourth quarter, Uber’s revenue from its ride-hailing and Uber Eats businesses slipped by 1%.

Uber’s revenue decline is surprising given Lyft’s revenue grew by 15% in the same period. The company states in its S-1 that it expects its share of the bookings to decline in the near-term which means that the company’s slow-to-no growth pattern of 2018 could continue in 2019

Risk No. 3 Uber’s profitability, and lack thereof

The good news: Uber’s profits from ride hailing and Uber Eats was positive by the end of 2018
The not-so-good news: Uber’s method of calculating earnings leaves out a lot of important things

Throughout its S-1, Uber tries to get investors to focus on its core business, aka ride-hailing and Uber Eats, as separate from the company’s future bets like bikes and scooters, trucking, and autonomous vehicles. We think this focus is helpful when analyzing revenue because it exposes possible issues in the core platform like we just discussed. But we think the company’s method of calculating how much money it makes on its core platform—contribution profit or contribution margin—is confusing at best and misleading at worst.

We applaud the company’s attempt to clarify how much money it makes on its core platform but the details show the company simply isn’t providing enough clarity. The basic idea behind the company’s contribution margin calculation is that it subtracts the costs that are directly allocated to the core business from the revenue for the core business. Using this method, the company made 9% in profit from its core business in 2018.

Our issue is that the company excludes $2 billion of expenses from this calculation which are described as unallocated research and development, as well as general and administrative costs. Through its contribution margin calculation, the company is trying to show that it can make money on its core businesses. We think investors should ignore this claim for now until the company can explain how 57% of its research and development and general administrative costs are not essential to supporting its ride-hailing and Uber Eats businesses.

Sometimes companies can make up new methods to analyze financials which are helpful to investors, others are simply a sleight of hand. Uber may mean well with its contribution margin calculation but we contend it isn’t a useful enough metric with which to bother. The simple answer is Uber lost more than $3 billion in 2018 and no slicing or dicing is going to tell a better story.

Risk No. 4: Uber’s dependence on its key markets

The good news: Uber’s largest markets are the best markets for ride-hailing
The not-so-good news: Some of Uber’s largest markets are pushing back on ride-hailing

Nearly a quarter of Uber’s revenue comes from five markets: Los Angeles, New York, the San Francisco Bay Area, London, and Sao Paulo. In its S-1, Uber discusses issues in three of these markets. New York City instituted a limit on new vehicle licenses last year and imposed new minimum pay rates for drivers in February. San Francisco is considering a surcharge for ride-hailing. And London, which already once cancelled Uber’s license, is set to re-evaluate the company’s license in August 2019. The issues aren’t limited to these markets though. Honolulu has put an upper limit on surge pricing and several countries—Argentina, Germany, Italy, Japan, South Korea, and Spain—have either limited or outlawed ride-hailing altogether.

At a minimum, the regulatory trend in Uber’s most important markets isn’t going in the right direction. There’s also a possibility that some of the regulatory changes will adversely impact Uber’s revenue–most importantly in New York City where Uber has warned the regulatory changes will have a negative impact.

Risk No. 5:  Acquisitions

The good news: Uber is acquiring companies to grow
The not-so-good news: Acquisitions are risky

Last month, Uber agreed to acquire Careem, a Dubai-based ride-hailing company, for $3.1 billion. While this acquisition could be a great opportunity for international growth, it presents two major risks. First, the company hasn’t disclosed any of Careem’s financials so it’s not possible to know what impact it will have on Uber’s profitability. Given that Careem serves markets in the Middle East and North Africa that are likely lower margin than its current average, it seems likely that integrating Careem will increase Uber’s losses for the near-term. Second, Careem operated in challenging markets. In the S-1, Uber highlights the increased risk of Careem accepting cash, which creates more issues in tracking payments and could lead the company to run afoul of anti-corruption laws.

Outlook: Continued messiness

Some investors may see Uber as an essential stock for a balanced tech portfolio since it’s the de facto leader in shared transportation and a leading developer of autonomous vehicles. The company seems to have resolved 2017’s leadership and culture issues that started the #DeleteUber campaign, and led to the ouster of founder and CEO Travis Kalanick from day-to-day management (he remains on the board). The company dedicated 16 pages of its S-1 to an impressive and robust discussion of corporate governance including new management hires, board members, and the structure and operation of board committees.

Uber also has bucked the trend in Silicon Valley by eliminating its previous dual class share structure. While many tech companies going public have a special share class for founders that give them the ability to control the company as long as they want, Uber has a one-share, one-vote structure which will give public investors the ability to make changes if they want to. Uber’s new CEO Dara Khosrowshahi is demonstrating the strong leadership he was known for at Expedia, and is signing up to be held accountable by shareholders. All of this is positive for the company and for investors in the stock.

But as we’ve discussed, the details are messy and are likely to stay that way for a while. Uber’s user and trip numbers are growing but its revenue and profits aren’t—indicating the company is pushing for growth at the expense of profits. It is expanding aggressively around the world, including with large acquisitions, which creates risk for the company and investors. And there is no indication if or how the company will achieve sustainable profitability. In fact, the company states that it expects its losses to grow “into the future.”

As we said about Uber’s primary rival, Lyft, there isn’t anything as important as profits for investors over the long haul. The true value of any company is the present value of future cash flows–always has been and always will be. No matter how Uber is valued today, it will someday be valued on cash flows, too. And that means having some sense of if, when, and how Uber could be profitable is critical when analyzing its IPO as the potential start of a long-term investment. While investors may feel they need to own Uber as part of a tech portfolio, they should expect it to be a volatile holding until the company has reached a point of steadier performance and some indication of future profitability. In the near term, Uber’s market value will be based mostly on hope for the future and investors’ fear of missing out on the next big thing. In the future, though, Uber’s stock price will be based on the company’s intrinsic value which we have no way of predicting today.